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Western EuropeMay 1 2006

The left-right march to revival

The prospect of four years of political stability has helped lift the pessimism that has surrounded Portugal’s economy. Peter Wise explains.
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Economic growth is slow. Unemployment has doubled over the past five years. The budget deficit is twice the level permitted by the EU. But the mood in Portugal is positive.

Renewed confidence lies at the heart of this optimism. Over the past year, the country has begun to believe again in the possibility of growth and reform and shake off the pessimism of the previous three years of political instability and economic stagnation.

“Portugal hit the bottom of the curve last year and is now back on the path to sustained growth,” says Paulo Teixeira Pinto, chief executive of Millennium BCP, the country’s biggest listed bank. “We have not experienced a similar level of economic confidence for many years.”

In March, Mr Teixeira Pinto became one of the main protagonists of this new climate of confidence when BCP launched a ?4.3bn takeover bid for Banco BPI, Portugal’s fourth largest listed bank. Six weeks earlier, Sonae, a Portuguese conglomerate, announced a €11.2bn offer for Portugal Telecom, the country’s biggest takeover bid to date.

A new optimism

“Big business deals and investment projects like these represent a new attitude in Portugal,” says José Sócrates, the prime minister who led his centre-left Socialist Party to victory in a general election in February 2005. “The word that best describes that attitude is ‘confidence’.”

The election of Mr Sócrates, a modernising, market-friendly socialist, has made an important contribution to the new climate. For the first time in its history, his Socialist Party enjoys a comfortable overall majority in parliament, ensuring the country four years of stable government.

In January this year, Aníbal Cavaco Silva, Portugal’s conservative prime minister from 1985 to 1995, defeated five left-of-centre candidates to become president, bringing to an end a long cycle of political volatility.

His convincing first-round victory was ostensibly a defeat for the socialist government. The new president, a former leader of the centre-right Social Democrats, and the prime minister represent Portugal’s two main opposing political parties.

But more seems to unite Mr Sócrates and Mr Cavaco Silva than divides them. Both share a concern to revive the flagging economy and a preference for pragmatic action over rhetorical grandstanding.

“Although they represent different political families, there is a clear convergence of political wills between the prime minister and the president to press ahead with reform,” says Mr Teixeira Pinto.

In a country that has had four prime ministers in the past four years and three national elections in the past 15 months, the prospect of almost four years of stability uninterrupted by political campaigning has helped lift the economic mood.

“There is a clear perception that the country is changing,” says Mr Teixeira Pinto. “People sense drive, initiative and a sense of responsibility in government. This is creating confidence, which, more than any budget or economic policy, is crucial for investment.”

In his first year in government, Mr Sócrates has used his solid majority in parliament to push through a series of measures aimed at putting Portugal back on a path of sustained economic growth and bringing its spiralling budget deficit under control.

He began by increasing the main rate of value added tax from 19% to 21%, breaking an election promise not to raise taxes. It was the toughest decision he has had to make, he says, but does not regret a measure that showed his government had “the courage and determination” to tackle the country’s deficit crisis.

More painful measures followed: phasing in an increase in the minimum retirement age for state employees from 60 to 65, cutting their sick pay from 100% to 65% and holding down public sector wage increases.

Doctors, nurses, teachers, the police, the armed forces, judges and public administration workers have all staged strikes and protests. But the public mood, reflected in opinion polls, remains in the government’s favour.

“I think everyone understands that these reforms are needed and are now under way,” says António Guerreiro, chairman and chief executive of Banco Finantia, an independent investment bank. “The government has identified the problems and is implementing courageous measures to address them.”

Budgetary concerns

The most immediate economic challenge facing the government is the budget deficit, which stood at 6.8% of GDP – more than double the maximum permitted under the EU’s growth and stability pact – when the government took office.

Mr Sócrates persuaded the European Commission to allow Portugal three years to bring the deficit into compliance with the pact. Requiring governments to comply within one year, as the Commission had previously insisted, was “an invitation to disguise spending and implement one-off measures” that were doomed to failure, he argued.

Unpopular decisions

The government succeeded in cutting the deficit to 6% of GDP in 2005, an improvement on its target of 6.2%. But reaching 3% by 2008 will require unpopular government decisions and inevitably prove painful for sections of Portuguese society. As Mr Sócrates recently warned: “The hardest part is yet to come.”

However, he has deliberately set out to end what he calls the obsession of previous governments with the deficit, stressing that disciplining public finances is an essential pre-condition – not an impassable barrier – to sustained economic growth.

Rui Martins dos Santos, an economist and director of Banco Português de Investimento, agrees that the only definitive solution for the deficit is economic growth. “Portugal’s budget deficit is more a consequence than a cause of weak economic growth,” he says. “Public spending as a percentage of GDP is close to the average EU level and is among the lowest in per capita terms. The emphasis has to be on increasing economic growth to cut the deficit, not vice versa.”

GDP growth is recovering slowly from a recession in 2003, when it fell 1.1%. It inched up by 0.3% in 2005, the fourth year of growth below 1% in what is proving to be the country’s longest downturn since the return of democracy in 1974. Private consumption remained the main driver, but expanded at a slower pace of 2%, down from 2.4% in 2004. Investment fell by 2.9%.

Higher than expected growth of 0.7% in the last quarter of 2005 has encouraged moderate optimism. Vítor Constâncio, governor of the central bank, has said the bank’s 0.8% growth forecast for 2006 could be revised slightly upwards. But he stressed that the recovery this year would be moderate.

Finance minister Fernando Teixeira dos Santos is keeping to the government’s forecast of 1.1% GDP growth this year. “Growth over the medium term will be based on external trade and a higher propensity to invest,” says Gonçalo Pascoal, an economist with BCP. “Retail sales are clearly recovering and consumer confidence has picked up slightly. But we expect only moderate growth in consumption in 2006.”

Unemployment, which reached 8% at the end of 2005, is not expected to fall before 2008.

Santander Totta, Portugal’s third largest private sector bank, forecasts that Portugal will only converge with average EU growth rates towards the end of the decade. Growing above the EU average was once an overriding concern in Portugal. But Mr Martins dos Santos believes that trying to keep up with this moving target can prove “eternally frustrating”.

“What counts,” he says, “is whether the economy is growing in absolute terms and there is no doubt that Portugal is on the road to recovery.”

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